Dolphy D'Souza (Partner, S.R. Batliboi & Co LLP)

Transcription

1 Impact on MAT from First Time Adoption (FTA) of Ind AS Date: February 02,2017 Dolphy D'Souza (Partner, S.R. Batliboi & Co LLP) As the book profit based on Ind AS compliant financial statement is likely to be different from the book profit based on existing Indian GAAP, the Central Board of Direct Taxes (CBDT) constituted a committee in June, 2015 for suggesting the framework for computation of minimum alternate tax (MAT) liability under section 115JB for Ind AS compliant companies in the year of adoption and thereafter. The Committee submitted first interim report on 18th March, 2016 which was placed in public domain by the CBDT for wider public consultations. The Committee submitted the second interim report on 5th August, 2016 which was also placed in public domain. The comments/ suggestions received in respect of the first and second interim report were examined by the Committee. After taking into account all the suggestions/ comments received, the Committee submitted its final report on 22nd December, This article discusses the final proposed provisions only with respect to first time adoption (FTA) of Ind AS and the consequences for companies that fall under MAT. The final provisions are a substantial improvement from the earlier draft, and provides a lot more clarity, and makes the FTA Ind AS MAT neutral in several cases. Many of this author s recommendations, in the article published earlier in Tax Sutra, have been accepted in the final provisions. However, there are certain provisions that are not clear or are confusing. Hopefully, the CBDT will provide clarifications in due time. The accounting policies that an entity uses in its opening Ind AS balance sheet at the time of FTA may differ from those that it previously used in its Indian GAAP financial statements. An entity is required to record these adjustments directly in retained earnings/reserves at the date of transition to Ind AS. The Committee noted that several of these items would subsequently never be reclassified to the statement of P&L or included in the computation of book profits. The final provisions on MAT for FTA adjustments in Ind AS retained earnings on the opening balance sheet date that are subsequently never reclassified to the statement of P&L are summarized below. It may be noted that those adjustments recorded in other comprehensive income and which would subsequently be reclassified to the profit and loss, shall be included in book profits in the year in which these are reclassified to the profit and loss. Items Changes in revaluation surplus of Property, Plant or Equipment (PPE) and Intangible assets (Ind AS 16 and Ind AS 38). An entity may use fair value in its opening Ind AS Balance Sheet as deemed cost for an item of PPE or an intangible asset as mentioned in paragraphs D5 and D7 of Ind AS 101. The point of time it will be included in book profits This item is completely kept MAT neutral based on the existing principles for computation of book profits under section 115JB of the Act. It provides that in case of revaluation of assets, any impact on account of such revaluation shall be ignored for the purposes of computation of book profits. Therefore changes in revaluation surplus will be included in book profits at the time of realisation/ disposal/ retirement or otherwise transfer of the asset. Consequently, depreciation shall be computed ignoring the amount of aforesaid retained earnings adjustment. Similarly, gain/loss on realisation/ disposal/ retirement of such assets shall be computed ignoring the aforesaid retained earnings adjustment. Page 1 of 8

2 Gains and losses from An entity may use fair value in its opening Ind AS investments in equity Balance Sheet as deemed cost for investment in a instruments designated at fair subsidiary, joint venture or associate in its separate value through other financial statements as mentioned in paragraph D15 of comprehensive income (Ind Ind AS 101. In such cases retained earnings adjustment AS 109) shall be included in the book profit at the time of realisation of such investment. Cumulative translation differences Therefore this item is also completely kept MAT neutral. An entity may elect a choice whereby the cumulative translation differences for all foreign operations are deemed to be zero at the date of transition to Ind AS. Further, the gain or loss on a subsequent disposal of any foreign operation shall exclude translation differences that arose before the date of transition to Ind AS and shall include only the translation differences after the date of transition. In such cases, to ensure that such Cumulative translation differences on the date of transition which have been transferred to retained earnings, are taken into account, these shall be included in the book profits at the time of disposal of foreign operations as mentioned in paragraph 48 of Ind AS 21. Therefore this item is also completely kept MAT neutral. Any other item such as remeasurements of defined benefit plans, decommissioning liability, asset retirement obligations, foreign exchange capitalisation/ decapitalization, borrowing costs adjustments, etc To be included in book profits equally over a period of five years starting from the year of first time adoption of Ind AS. Section 115JB of the Act already provides for adjustments on account of deferred tax and its provision. Any deferred tax adjustments recorded in Reserves and Surplus on account of transition to Ind AS shall also be ignored. Let s consider, how the above provisions will work at a practical level. Consider a company has a net worth of Rs 500 crores, and therefore falls under first phase of Ind AS implementation. Its date of transition to Ind AS is 1 April, 2015; comparative period is financial year , and first Ind AS reporting period is financial year The company is engaged in several businesses and makes the following seven transition decisions at 1 April, 2015 in order to comply with Ind AS. 1. The company s accounting policy for fixed assets is cost less depreciation under Ind AS. However, as per option available in Ind AS 101 all fixed assets are stated at fair value at date of transition. The revalued amount is a deemed cost of fixed assets at 1 April, In other words, the company s policy is not to use revaluation on a go forward basis as the accounting policy. The uplift on revaluation is recorded in retained earnings and will never be recycled to the statement of P&L. Page 2 of 8

3 1. In the stand-alone accounts the company has several investments in subsidiaries which under Indian GAAP are stated at cost less diminution other than temporary. Under Ind AS the company will continue to account for them at cost less impairment. However, as per option available in Ind AS 101 the investments in subsidiaries are stated at fair value at date of transition. The fair value is the deemed cost of investments at 1 April, Subsequently, the investments in subsidiaries are not fair valued but tested only for impairment. The net impact of upward fair valuation in some cases and downward fair valuation in other cases is recorded in retained earnings and will never be recycled to the statement of P&L. 1. Under Indian GAAP, the company discloses assets under a service concession arrangement (SCA) as intangible assets at cost and which does not include construction margin. On date of transition, the company accounts for the intangible assets in accordance with Ind AS 11 (Appendix A), treating them as service concession assets. Consequently, under Ind AS 11 (Appendix A), the construction margin is also reflected in the value of the intangible asset. Therefore at transition date, the value of the intangible assets will be increased with a corresponding increase in retained earnings. The increase in retained earnings will never be recycled to the statement of P&L. However, the increase in the value of the intangible asset will be amortized in the future years. 1. At 31 March 2015, the Company has a lease equalization liability under Indian GAAP for an operating lease. Under Ind AS 17, the Company is required to charge operating lease payments in the statement of P&L without equalizing the lease payments, since those lease payments are indexed to inflation. Consequently on the transition date, the company reverses the lease equalization liability and takes the credit to retained earnings. The increase in retained earnings will never be recycled to the statement of P&L. 1. The Company has a cash flow hedge reserve at 31 March 2015 under Indian GAAP, which meets all hedge accounting requirements under Ind AS. The Company decides to continue with hedge accounting. In accordance with Ind AS 101, the Company is required to maintain the cash flow hedge reserve, and recycle the same to the statement of P&L, in accordance with the principles of Ind AS The Company has a foreign branch and a positive foreign currency translation reserve (FCTR) in Indian GAAP standalone accounts at 31 March In accordance with Ind AS 101, it restates the FCTR to zero on 1 April, the date of transition. Consequently the corresponding effect is taken to retained earnings. The increase in retained earnings will never be recycled to the statement of P&L. 1. In addition to investments in subsidiaries the company has investments in unquoted securities that are held long term for strategic reasons, but which are neither, subsidiaries, associates or joint ventures. The Company designates these investments as FVOCI (Fair Value through Other Comprehensive Income). As per this accounting policy choice, the fair value changes are permanently recorded in reserves (not retained earnings) and are never recycled to the statement of P&L. As per the final provisions in the Finance Bill, 2017, the MAT implication for the above seven FTA items is given below along with the author s observations. Transition MAT implication as per Final date Provisions adjustments Author s Observations Page 3 of 8

4 Fixed asset revaluation The Fixed asset revaluation is proposed to be made completely tax neutral. This is achieved by recommending the following: The revalued portion will not be included in book profits No depreciation will be allowed on the revalued portion for determining future book profits The revalued portion will be ignored for determining future profit on sale of those assets. Fixed asset revaluation should not result in any MAT liability, since currently for MAT purposes the depreciation on revaluation is added back for determining book profits and amount standing in revaluation reserve is picked up for MAT levy in the year of retirement/disposal of asset. Besides capital gains in normal tax computation are calculated on the basis of block of asset concept, and revaluation in books does not impact capital gains. Therefore since revaluation of assets does not have any impact on MAT on an ongoing basis, revaluation of fixed assets on FTA of Ind AS should also not be included in book profits. The Final provisions is therefore a step in the right direction. Fair valuation of Investments in subsidiaries as deemed cost In such cases retained earnings adjustment shall be included in the book profit at the time of realisation of such investment for MAT computation. Therefore this item is also completely kept MAT neutral. Under the current MAT provisions, profit on sale of investments is included in book profits in the year of sale for determining MAT liability. Similar rule should apply for fair value changes also. In other words, the fair value changes should continue to be included in determining the book profits for MAT purposes at the time of the sale of the investment. This would also be consistent with treatment prescribed in the final provisions for investments recorded at FVOCI on ongoing basis as well as the treatment prescribed for fixed assets. The Final provisions is therefore a step in the right direction. Accounting of SCA Other Adjustments recorded in retained earnings and which would otherwise Taxability on an ongoing basis Page 4 of 8

5 margins never subsequently be reclassified to the statement of P&L should be included in book profits over a period of five years. In the Indian GAAP scenario, the intangible assets were recorded at cost (without the construction margin). In Ind AS, the intangible assets are recorded at a higher amount since it also includes the construction margins. Under Ind AS the higher MAT that is paid in the initial year of the SCA because of the construction margins may be offset by lower profits in future years due to a higher amortization charge, though this may not always be the case. Even if MAT offset was available in future years, Ind AS would cause huge cash outflow on account of MAT in the initial years. This cash outflow may or may not be recovered in future years. In the authors opinion, the implementation of Ind AS should not result in a higher income tax payment or MAT payment. In other words, the implementation of Ind AS should as far as practicable be tax neutral. Under Indian GAAP, the normal income tax computation and MAT computation was based on toll revenue and did not include any construction margin. Further, under Indian GAAP, the book profits for purposes of MAT included an amortization charge on the intangible asset without the loading of construction margin. The same rule should continue under Ind AS as well for determining book profits for MAT purposes. Taxability on FTA With respect to the FTA adjustment, the Final provision proposes that revaluation of the intangible asset will not be tax Page 5 of 8

6 Restating lease Equalization Liability to Zero neutral. What is tax neutral is the fair valuation of intangible assets only in accordance with D7 of Ind AS 101. This is therefore a retrograde provision. However, unlike the earlier draft provisions, the uplift will be included in MAT profits over a period of five years instead of three years. To that extent there is relief. Other adjustments recorded in retained It may be pointed out that under earnings and which would otherwise Indian GAAP the Company s never subsequently be reclassified to the book profits were reduced statement of P&L should be included in because of the creation of a book profits over a period of five years. lease equalization liability. This has an impact of reducing MAT liability initially followed by increasing MAT liability when the lease equalization liability is reversed. It is therefore fair that if the lease equalization liability is reversed under FTA of Ind AS, it should be subjected to MAT. However it is completely unreasonable that it should be included in the book profits over a short period of five years. The reversal of the lease equalization liability is not a voluntary decision of the Company. It is required by Ind AS standards. Therefore the most appropriate course of action is to allocate the reversal of lease equalization liability, in the same manner as it would have occurred under Indian GAAP or atleast over a period of 10 years. Continuation of cash flow hedge reserve Those adjustments recorded in reserves (not retained earnings) and which would subsequently be reclassified to the statement of P&L should be included in book profits in the year in which these are reclassified to the statement of P&L It may however be noted that under the earlier draft provisions the requirement was to include the adjustment over a period of three years. Increasing that period to five years is certainly a relief. This is tax neutral since the implications with respect to MAT under Indian GAAP and Ind AS are the same. Page 6 of 8

7 Restating FCTR to Zero An entity may elect a choice whereby the In the earlier provisions this cumulative translation differences for all would have been included in foreign operations are deemed to be zero MAT profits over a period of at the date of transition to Ind AS. Further, three years. In the final the gain or loss on a subsequent provisions this item is kept disposal of any foreign operation shall completely MAT neutral and exclude translation differences that arose hence is a step in the right before the date of transition to Ind AS and direction. shall include only the translation differences after the date of transition. In such cases, to ensure that such Cumulative translation differences on the date of transition which have been transferred to retained earnings, are taken into account, these shall be included in the book profits at the time of disposal of foreign operations as mentioned in paragraph 48 of Ind AS 21. Therefore this item is kept completely MAT neutral. Investments recorded at FVOCI To be included in book profits at the time of realisation This is tax neutral since the implications with respect to MAT under Indian GAAP and Ind AS are the same. Hence it is a step in the right direction. Reference Year for FTA adjustments The reference year for first time adoption adjustments is also clarified in the proposed final provisions. In the first year of adoption of Ind AS, the companies would prepare Ind AS financial statement for reporting year with a comparative financial statement for immediately preceding year. As per Ind AS 101, a company would make all Ind AS adjustments on the opening date of the comparative financial year. The entity is also required to present an equity reconciliation between previous Indian GAAP and Ind AS amounts, both on the opening date of preceding year as well as on the closing date of the preceding year. It is proposed that for the purposes of computation of book profits of the year of adoption and the proposed adjustments, the amounts adjusted as of the opening date of the first year of adoption shall be considered. For example, companies which adopt Ind AS with effect from 1 April 2016 are required prepare their financial statements for the year as per requirements of Ind AS. Such companies are also required to prepare an opening balance sheet as of 1 April2015 and restate the financial statements for the comparative period In such a case, the first time adoption adjustments as of 31 March 2016 shall be considered for computation of MAT liability for previous year (Assessment year ) and thereafter. Further, in this case, the period of five years proposed above shall be previous years , , , and The above provisions are slightly confusing because, the FTA adjustments are made at 1 April 2015, whereas the final provisions allude to FTA adjustments at 31 March 2016 to be considered for computation of MAT. Does that mean that the FTA adjustments made at 1 April, 2015 are trued up for any changes upto the end of the comparative year, i.e, 31 March 2016? Other General Accounting Considerations Page 7 of 8

8 The positive impact of MAT credit due to extension of MAT set off availability from 10 years to 15 years can only be recognized in the quarter of January-March 17 and not the quarter of October December 16. This is because the announcements are made in February and are not substantive enactment for December quarter. They are substantive enactment/enactment only in the March quarter once passed by the Lok Sabha/ Parliament. Conclusion Companies need to make careful choices of FTA options to minimize a negative MAT impact. They can make those choices up till financial statements for year ended 31 March 2017 are finalized. However, changes in those choices will cause significant fluctuations in quarterly results. For example, a company decides to carry forward fixed assets at previous GAAP carrying value as a transition choice to avoid any MAT liability on fair value uplift. Subsequently, in the last quarter, the final provision treats the fair value uplift on fixed assets to be completely MAT neutral. Because of the clarity, the Company prefers to fair value the fixed assets from the transition date instead of carrying them at previous GAAP carrying value. This would mean that the lower depreciation charge in the earlier quarters and the comparative period will have to be adjusted, thereby resulting in significant change in the reported numbers in the last quarter. As a bold step, the Government could have considered abolishing MAT, since the fiscal path is to simplify tax and to abolish various tax exemptions. However, not many were expecting an abolishment since tax exemptions will phase out over a period of time. However, in future budgets, one should look forward to an abolishment of MAT. Page 8 of 8